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  • Cliffs Natural Resources (CLF): Can This U.S. Miner Offset The Impact Of Increasing Global Supply? 0 comments
    Jan 17, 2014 5:42 PM | about stocks: CLF

    Cliffs Natural Resources will face stiff competition from Australian miner - Roy Hill. The U.S. Export-Import bank, signed off on a loan deal worth $694 million with Roy Hill. Roy Hill will use the funds to buy bulldozers and trucks from Caterpillar (NYSE:CAT), locomotives from General Electric (NYSE:GE), and drilling rigs from Atlas Copco (OTCPK:ATLCF). This equipment will be used for Roy Hill's Western Australia project, which will produce 55 million metric tons of iron ore annually. It expects to start shipment by 2015.

    This project will create the following risks for the U.S. iron-ore miners:

    • With the increase in global supply, iron-ore prices are expected to fall. Analysts expect that due to the additional supply, the price may fall to $120 per metric ton this year and $110 in 2015 from the current price of around $131.

    • With this project, Roy Hill can displace potential North America iron-ore sales to Asia because of the mine's proximity to Asian markets and thus lower shipping costs. Also, cheaper iron ore means steel from Asian mills will also become cheap, and additional steel from Asia can displace U.S. made steel, cutting domestic demand of iron-ore pellets.

    Cliffs accounts for 45% of the supply of iron pellets in the U.S., while the rest of the supply is owned by steel mills. Hence, weak U.S. steel demand will directly affect the company's revenue.

    How this additional supply may affect the company's North American iron-ore segments?

    U.S. Iron-Ore Segemnt: Cliffs' advantage is that most of its domestic volume is contracted long-term. Under these contracts, the minimum volume of iron-ore purchase for buyers is fixed, with an option to purchase additional supply.

    The company's long-term contracts are as follows:

    1. Essar Steel Algoma (Contract validity till 2024)

    2. A K Steel (NYSE:AKS) (Contract validity till 2023)

    3. Severstal (OTC:SVJTL) (Contract validity till 2022)

    Cliffs also has a joint venture with Arcelor Mittal (NYSE:MT) at different facilities (mentioned below). It is expected that this venture will continue for years to come.

    1. Cleveland Works and Indiana Harbor West facilities (Agreement Expiration in 2016)

    2. Indiana Harbor East facility (Agreement Expiration in 2015)

    All of these companies account for more than 60% of Cliffs' total U.S. iron-ore product revenue. Although most of these contracts are linked to international prices, the volatility on the company's revenue is lower, because it structures the contracts on a 12-month average price. Therefore, these contracts allow the company's U.S. iron-ore segment to maintain its sales volume despite the increase in global supply.

    Eastern Canadian iron-ore segment:

    Cliffs' Eastern Canadian iron-ore cash cost, which denotes cost of goods sold and operating expenses less non-cash expenses such as depreciation, depletion, and amortization per metric ton, is higher than its other two segments. The cash cost per metric ton (mt) in 2013 for the U.S. and Asia Pacific iron-ore stood at $65-$70, whereas the cash cost per mt for Eastern Canada was in the range $90-$95.

    In addition, the company sells the iron-ore volume from this region on a spot-price basis. Therefore, high cash cost and a lower price will significantly affect its profit. To cut the cost, the company may increase production, but this is possible only if the price stays above $120 per metric ton. In case the price falls below $100, it plans to shut down the mine. Analysts expect the company to reveal the decision before the end of February. As the iron-ore price is expected to stay above $120 per metric ton, the company will likely increase production from this mine.

    Overall impact on the company

    Additional iron-ore supply from Roy Hill's Australian mine will affect Cliffs. The company's Eastern Canada segment's revenue will be affected due to higher cash cost and lower iron-ore prices. On the other hand, most of its U.S. iron-ore volume is committed under a long-term contract, which will help it to maintain the volume. However, due to additional low cost Asian steel supply in the future, the company will face challenges from lower iron-ore prices, as its customers who are not in a long-term contract can look for supplies from the competing Asian markets.

    MissionIR provides investor relations services to publicly traded companies in exchange for compensation. This article may be part of our efforts to widen a client's exposure. To read our full disclaimer, visit http://disclaimer.missionir.com

    Stocks: CLF
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